10 Monetary Policies Used by the Federal Reserve You Must Know

Since the short recession of 2020, the Federal Reserve pledged to use all tools available to help rebuild the economy. Although, the Federal Reserve decided to maintain the average inflation rate below 2%, increase monthly treasury securities by 80 billion, and mortgage backed securities by 40 billion. The focus was more on the Federal Reserve decision to keep the federal fund rate between 0 - 1/4 percent while looking to reach full employment.

Before discussing the reason, these decisions are essential for our economy. One must know the ten monetary policies used by the Federal Reserve to strengthen our economy.

1. Open Market Operation

Open Market Operation (OMO) refers to the purchase and sale of eligible securities (bonds) in the open market (Banks) by the Federal Reserve to adjust the inflation rate.

2. Discount Window and Discount Rate

The discount window is designed to help depository institutions borrow short-term liquidity from the Federal Reserve to manage their liquidity risk and avoid negative customers’ experiences. As of March 16, 2021, commercial banks or depository institutions may borrow up to 90 days, repayable and renewable by the borrower daily.

The discount rate is the interest rate charged to depository institutions on loans by the Federal Reserve within a discount window.

From July 19 through July 28, 2021 (PDF), the Board and the Federal Open Market Committee established a current primary credit rate of 0.25. The secondary credit rate was set to 50 basis points above the primary credit rate. While the seasonal rate will be reset every two weeks.

3. Reserve Requirements

The Federal Reserve requires all depository institutions to maintain a minimum amount of reserve against clients' deposits based on their liabilities. On March 26, 2020, the Board and the Federal Open Market Committee sets the reserve requirement ratios to zero.

4. Interest on Reserve Balances

The Federal Reserve pays interest on reserve balances. The interest rate is updated daily, except for federal holidays.

5. Overnight Reverse Repurchase Agreement Facility

In the overnight reserve repurchase agreement, the Desk agrees to sell and purchase back the same securities to a counterparty at the future date. This transaction temporarily reduces the supply of reserve balances in the banking system. The Desk facilitates the acquisition of money market securities when the rate falls below the interest on reserve balances (IORB) rate.

According to the Federal Reserve statement of December 16, 2015, the federal fund rate is between 1/4 to 1/2 at the offering rate of 0.25 percent with a limit of 30 billion treasury securities per day.

6. Term Deposit Facility

Through the term deposit facility, the Federal Reserve offers interest rate payments on term deposits to eligible institutions on their balance at the Reserve Banks. These institutions must send a request to participate in the program.

7. Commercial Paper Funding Facility

On March 17, 2020, the Federal Reserve established a Commercial Paper Funding Facility or CPFF to support the flow of credit for families, businesses, and improve the employment rate. The goal of the purchase was to increase liquidity to the short-term market by purchasing commercial paper. However, the Federal Reserve stopped this operation on March 31, 2021.

The Federal Reserve also ceased the operation of the Primary Dealer Credit Facility, and Money Market Mutual Fund Liquidity Facility on March 31, 2021. But they decided to maintain the Main Street Lending Program until January 8, 2021.

8. Central Bank Liquidity Swaps

Central Bank Liquidity Swaps is the collaboration of the top 9 Foreign Banks worldwide to ease the liquidity in the global market using the U.S dollar as a transaction tool.

The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank facilitate the provision of U.S Dollar in up to $60 billion each for the Reserve Bank of Australia, the Banco Central do Brasil, the Bank of Korea, the Monetary Authority of Singapore, the Banco de México, and the Sveriges Riksbank (Sweden) and $30 billion each for the Danmarks National bank (Denmark), the Norges Bank (Norway), and the Reserve Bank of New Zealand. FOMC extended the program until December 31, 2021.

9. Foreign and International Monetary Authorities (FIMA) Repo Facility

FIMA was established on March 31, 2020. The purpose was to support the liquidity of the U.S Dollar for foreign central banks and financial institutions that hold accounts at the Federal Reserve Bank of New York. Under FIMA, foreign central banks and financial institutions can utilize their U.S. Treasury securities held with the Federal Reserve in exchange for U.S. dollars.

10. Standing Overnight Repurchase Agreement Facility

SRF serves as a backstop for liquidity and financing for its counterparties. FOMC buys the security with the agreement to sell it the next day at the minimum bid price. The securities accepted are treasury securities, agency debt securities, and agency mortgage-backed securities. The SRF transaction will be between FOMC and primary dealers, and depository institutions.

All things considered, one can reflect the problem of the inflation rate, wealth gap, multiplier effect through Federal Reserve spending. U.S inflation rate also affects the international market and foreign currency.

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